starbucks4ever (95.69)

Chinese mercantilism

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The main symptom of the coming crash in China is its foolish accumulation of toxic USD undertaken for no other reason than to keep the yuan low to export even more goods to America to buy even more USD.

In doing so, the Chinese are making the classic mistake of confusing paper wealth with real wealth. The amazing thing is that this folly has been exposed by Adam Smith as early as in 1776. It almost looks like 18th century again in China.

What is mercantilism in the first place? In a nutshell, mercantilists are paper bugs. They are ready to work day and night in the sweat of their brow, consume very little, but tirelessly produce, produce, and produce finished goods for the foreign market. In exchange, the foreign partners would happily offer them their own finished goods, but mercantilists would have nothing to to with them. Instead, they would accept nothing but paper. They would lock that paper in the box and sit on that box and imagine that they are rich. The specifics can vary. In the 18th century, bullion was the trading currency, so mercantilists would accept bullion in exchange for the goods. Today gold is a relic of the past, so the modern mercantilists accept pieces of paper that represent a commitment by the US government to print other pieces of paper. The ancient mercantilists were less stupid than the modern ones. At least the supply of gold could not be increased at a whim of some foreign government.

Which is another way of saying that China's leaders don't have a clue about economics and are still very much in the pre-Adam Smith mindset.

China's determination to support exports at any cost is foolish because it makes life better everywhere else in the world except China itself. The Chinese consumer still does not have cars, computers, refrigerators, or even lead-painted toys because everything he produces gets shipped abroad and because with his own artificially cheap yuans he cannot buy any of that stuff that Americans and Europeans buy essentially for free with their artificially expensive dollars and euros. As a compensation, the Chinese consumer gets news releases showing that his government has imported a record number of USD per capita. But since people can't eat dollars, especially when they are stored in a government vault and especially when the decision has been made not to import anything that dollars could possibly buy, this means the Chinese consumer gets essentially nothing. A Marxist would say that Chinese Communist Party is turning China into a colony whose labor resources are exploited to the full by foreign capital, and the Marxist would be right.

Already in the 18th century, people have realized that this policy is not only foolish, but also unsustainable. Wikepedia has this to say about accumulation of paper wealth:

"Hume famously noted the impossibility of the mercantilists' goal of a constant positive balance of trade. As bullion flowed into one country, the supply would increase and the value of bullion in that state would steadily decline relative to other goods. Conversely, in the state exporting bullion, its value would slowly rise. Eventually it would no longer be cost-effective to export goods from the high-price country to the low-price country, and the balance of trade would reverse itself. Mercantilists fundamentally misunderstood this, long arguing that an increase in the money supply simply meant that everyone gets richer. "

But there is an important point that even Hume missed. If a country that exports goods and imports bullion then throws all the imported bullion into the ocean, then it's back to square one, and the process can be repeated forever. And China does just that. It keeps a reserve to the tune of $2.4 Trillion. Every year dollar inflation eats away some 7-8% of this reserve, and every year they export some more goods to refill the coffers again. That's definitely an improvement to the original theory. If the classic mercantilists were idiots, then the modern mercantilists in Beijing are idiots to the second power.

You just did a better job explaining why I do not mind China's exchange rate policies, than I have done in the past. I think China can keep this up for another decade, but at some point their GDP growth will come to a halt, unless they embrace free market capitalism.

a) US dollars do have value, and it is highly unlikely that the US will default on debt to China. So, their paper wealth = value. This value is depreciating over time as we move towards a new equilibrium. This equilibrium will be acheived when China un-pegs its currency.

b) The production and export of goods has improved life for the average Chinese person. Jobs now pay more than ten years ago. Its also possible to be highly capitalistic in agriculture or small business there now compared to pre 1980's. There are far more millionaires and billionaires in China now than ever before. Medical care, education have improved tremendously. So, to say that locally they have not seen positive effects of the US export trade is highly incorrect.

Agriculture, small business, medical care and education are domestic industries that work for the local consumer. I think these successes on the domestic front happened despite, and not because of, misguided activities of the export sector. That sector has attracted some foreign investment in the past, which was a very good thing, but now it is an albatross around the country's neck. At some point the truth will come out that the only output from this sector is the incoming stream of USD that is quite useless. And in that case this whole sector is money-losing sector...unless it stops working for the benefit of Western consumers and starts forking for the benefit of Chinese consumers. But that would require a massive domestic stimulus which runs contrary to the ideology of market fundamentalism. Those Chinese economists who have picked their economics degree from Harvard will be worse then useless because they will be giving the wrong advice.

I think it is very telling. China became a hostage to the US. While Russia didn't fear collapse of the US financial systems because they sell raw materials mostly and don't much trade with the US, China decided to not rock the boar even though they had a risk of loosing huge amoutns of money on GSEs. But apparently they value US as export partner much more. In the end the meltdown occured anyway and GSEs almost collapsed. I strongly suspect that GSEs were bailed out to pay back China for its support. China then later was able to sell this paper back to the FED through their MBS purchase program. Ta-da.

Chinese played their cards smarter but they took much more risk. Russia got rid of GSE paper before meltdown but its economy was still damaged big time due to global financial meltdown.

Givern this little example I am thinking Chinese know what they are doing and they have the power to lean on the US "to do right by China".

It is true that americans explot cheap chinese labor. But look what China got in return - know-how on many western technologies, trained workforce ( these would've taken China 30-50 years to catch up on their own) , plus huge poltical leverage.

I keep saying chinese are much smarter than most people give them credit for. It is just their goals are often now obvious short term. Most westerners are too short sighted.

Your point is well taken. Having said that, i am extremely skeptical of all complex plans that are supposed to pay in the long term. They never do. Something always goes wrong in the meantime. The only way to go is to always demand tangible benefits here and now. So They don't win any respect from me for having plans that are so long-term that I cannot see where the benefits will come from. In the long term we are all dead.

P.S. A fascinating account of Putin's schemes. Thank you. By the way, do you know who is the main fool in this story? Putin. If something ever goes wrong between Russia and China, whom else is he going to ask for help but the good ol' US? Maybe Chavez or his Iranian "friends"?

A couple of things wrong with your piece: most of your assumptions are wrong, and most of your conclusions are wrong Other than that...

In no particular order, the idea that this newfound weath hasn't "trickled down" to the average Chinese person is contradicted by reality. In the past 10 years alone, WalMart has opened over 200 stores, Starbucks and McDonald's hundreds more, internet access has spread to millions, and China has become the largest automobile market in the world. (I use iconic American companies as examples, but there are a thousand times more domestic Chinese stores offering goods and services to Chinese citizens, and this could not be true if there was not "wealth" to spend on them.) Unsupported by government, as they now (mostly) are, they would not be building new buildings, opening new locations, selling ever more to "average citizens."

This is not some tiny elite that has benefited, it's widespread. Other sectors, such as healthcare and other service industries have prospered - and if they're not up to what we take for granted, well, that's not surprising; we had a very very big headstart. If this wealth is not universal, that's not a surprise either. It's not even universal here or in other so-called developed countries.

But to say that the average Chinese citizen has not benefited "because they export everything to someone else" is just flat wrong.

The "paper" that you seem to disdain has value, indeed. The idea that the US is going to default on its Chinese debt is unimaginable, unless a meteor hits the planet and extinguishes all life. (A far more likely scenario is that China refuses to continue buying, and we have trouble rolling over the debt, but that is a different issue.)

As for those piece of paper "having no value", I had to laugh. I recall another Asian country which exported vast quantities of goods to us, pegged its currency low, built itself from literally noting to the second largest economy on the planet, and began to scare us when they started using those "pieces of paper" to come here and buy up things like Rockefeller Center and other American treasures. Their name was "Japan", and it worked out pretty well for them.

The Chinese government, by artificially depressing its own currency and taking of our wont for "stuff" is using our own desire for finished goods against us. Even as we are hollowing out our own productive capacity, we are employing millions of Chinese, paying them for the privilege, and watching a vast transfer of technology and manufacturing prowess move across the ocean. This is not unlike what happened with Japan in the 1970's and 1980's, either - and even with their recent bubble troubles, the average Japanese has seen his life improve 10,000% since the 1950's, when their land was pretty much a flat island, bombed into rubble by the previous decade's war.

China is pretty much in that same position, a country which could barely feed itself and with almost no infrastructure to speak of, suddenly coming alive, producing vast quantities of finished consumer goods, building highways, factories and dams at a pace unimaginable a few years earlier - and doing it all thanks to those "pieces of paper" you seem to think so fleeting. Bah. They've got the program going, and very nicely I should say.

You're quite right about Japan having followed much the same policies; I'm less certain that 'it worked out pretty well for them'.

Certainly, Japanese citizens are much better off now than they were fifty years ago when their year on year double digit GDP growth began.

However, they are most certainly not as well off as their their fellow developed world citizens, and are arguably not even as better off as those European and North Americans are than they were 50 years ago (... your talk of 10,000% improvement is not something my Japanese friends and relatives would recognise, unless your baseline is a certain morning in August 1945). Trickle down there has been; but it has only been a trickle.

And I use that past tense advisedly: the phenomenal growth whose glory Japanese workers were encouraged to bask in during the sixties hit a wall back in the mid-seventies. The illusion was revived in the eighties with an asset price bubble. However, any standard of living improvements during the last twenty years or so have largely been generated by price depreciation as government protection has slowly and reluctantly been withdrawn from the domestic economy.

Japan's experience does not suggest inevitable disaster for Chinese mercantilism. But, on balance, I think that most Germans would probably be more satisfied with a then-and-now comparison of their country's post-war fortunes than would most Japanese.

Thanks, Goofy, for explaining things so well, and saving me a lot of typing.

The original post spouted some commonly held misconceptions of China. What people really should understand is that:

1. China will keep its population productively employed at all times and has the ability to do this by improving domestic living standards when exports sag.

2. China is the most competitive industrial power. They built up their knowledge base by providing labor for international companies. Now they are building a host of their own new companies that will compete much higher up the value chain.

3. China knows that the US will never pay back what it owes. The past 20 years have been about improving China's capacity to produce and compete.

Too many people cling to the fantasy of the free market always winning. They are fools and their investment returns will suffer as a result.